What Is Asset Backed Commercial Paper?

Asset backed commercial paper is a type of security that is secured by tangible assets and is usually issued for short-term financing needs. A typical asset that is used for this type of security are trade receivables. These securities are used as short-term investments and typically mature between 90 and 180 days.

Example

Company XYZ runs an operation and suddenly realizes that their business is losing liquidity. They would like to enhance their liquidity, but decide that they must find a short term solution. Asset backed commercial paper could be one method to support their short-term liquidity.

The first step they take is to sell some of their receivables to a bank. This immediately enhances the company's liquidity because they are getting cash on their receivables right away, instead of continuing to wait for their debtors. The bank then issues securities to willing investors, and these securities are backed by the expected cash flows for the receivables from Company XYZ. As soon as the company starts to receive their cash flow, they are expected to forward them to the bank. The bank can then use the cash to pay investors.

Risk Structure of Asset Backed Commercial Paper

The way ABCP is issued can sometimes make it a riskier investment than regular commercial paper. ABCP can be issued through a conduit, A conduit is an entity that is not associated with the company or balance sheet. The conduit's main purpose is to issue the securities. There are four different types of conduits, they are:

single-seller

multi-seller

security arbitrage

structured investment vehicles (SIVs)

Single vs. Multi-Seller

A single-seller security implies that the investment is secured against the cash flow of a single company. A multi-seller investment has more than one company as part of a portfolio. A multi-seller program offers diversification and can be less risky. Multi-seller ABCPs typically have something called credit enhancements. They are guarantees from either a company, or a bank, that mitigate the risk of the investment.

On the other hand, single-seller securities are usually extendible. This means that they can be extended beyond the original maturity date, especially if there are no funds available from a new issuance of commercial paper. Security arbitrage conduits use the ABCP issuance funds to buy term securities.

While most people believe that all commercial paper should be fairly safe investments, ABCP is tied to the value of the underlying assets. The values of these underlying assets can change with market conditions. ABCP can be backed by many different types of assets, which can include student loans, credit card debt or residential mortgages. If any of these markets suffer losses and consumer confidence, then the ABCP issuers might have problems repaying previously issued securities.

In 2007-2008, investors watched as their ABCP investments were unsuccessful due to underperforming assets that backed these securities. As investors started avoiding ABCP, financial institutions that relied on these funds experienced financial distress.

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